13 MBA 504: Financial Management And Analysis

week 13 1. Read and summarize chapter 29 of your financial management and analysis text book in at least 500 words.

-Thinking about what you just read, what strategic and financial plan would you put in place to help bring down inflation in America? There is no right or wrong answer. Just answer from your opinion and from what you read in the chapter.

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siness  that  maximizes  its  owners’  wealth  allocates  its  resources
efficiently, resulting in an efficient allocation of resources for society
as a whole. Owners, employees, customers, and anyone else who has a
stake  in  the  business  enterprise  are  all  better  off  when  its  managers
make decisions that maximize the value of the firm.
Just as there may be alternative routes to a destination, there may be
alternative  ways  to  maximize  owners’  wealth.  A  strategy is  a  sense  of
how to reach an objective such as maximizing wealth. And just as some
routes may get you where you are going faster, some strategies may be
better than others.
Suppose a firm has decided it has an advantage over its competitors
in  marketing  and  distributing  its  products  in  the  global  market.  The
firm’s strategy may be to expand into European market, followed by an
expansion into the Asian market. Once the firm has its strategy, it needs
a  plan,  in  particular  the  strategic  plan, which  is  the  set  of  actions  the
firm intends to use to follow its strategy.
The investment opportunities that enable the firm to follow its strat-
egy  comprise  the  firm’s  investment  strategy.  The  firm  may  pursue  its
strategy of expanding into European and Asian markets by either estab-
lishing  itself  or  acquiring  businesses  already  in  these  markets.  This  is
where  capital  budgeting  analysis  comes  in:  We  evaluate  the  possible
investment  opportunities  to  see  which  ones,  if  any,  provide  a  return
greater than necessary for the investment’s risk. And let’s not forget the
investment  in  working  capital,  the  resources  the  firm  needs  to  support
its day-to-day operations.
Suppose  as  a  result  of  evaluating  whether  to  establish  or  acquire
businesses,  our  firm  decides  it  is  better—in  terms  of  maximizing  the
value  of  the  firm—to  acquire  selected  European  businesses.  The  next
29-Strategy_FinancialPlan  Page 933  Wednesday, April 30, 2003  12:19 PM

step  is  to  figure  out  how  it  is  going  to  pay for  these  acquisitions.  The
financial managers must make sure that the firm has sufficient funds to
meet its operating needs, as well as its investment needs. This is where
the firm’s financing strategy enters the picture. Where should the funds
needed  come  from?  What  is  the  precise  timing  of  the  needs  for  funds?
To answer  these  questions,  working  capital  management  (in  particular,
short-term financing) and the capital structure decision (the mix of long-
term sources of financing) enters the picture.

Strategy and Owners’ Wealth Maximization
Often  firms  conceptualize  a  strategy  in  terms  of  the  consumers  of  the
firm’s  goods  and  services.  For  example,  you  may  have  a  strategy  to
become  the  world’s  leading  producer  of  microcomputer  chips  by  pro-
ducing  the  best  quality  chip  or  by  producing  chips  at  the  lowest  cost,
developing a cost (and price) advantage over your competitors. So your
focus  is  on  product  quality  and  cost.  Is  this  strategy  in  conflict  with
maximizing owners’ wealth? No.
To maximize  owners’  wealth,  we  focus  on  the  returns  and  risks  of
future  cash  flows  to  the  firm’s  owners.  And  we  look  at  a  project’s  net
present  value  when  we  make  decisions  regarding  whether  or  not  to
invest  in  it.  A  strategy  of  gaining  a  competitive  or  comparative  advan-
tage  is  consistent  with  maximizing  shareholder  wealth.  This  is  because
projects with positive net present value arise when the firm has a com-
petitive or comparative advantage over other firms.
Suppose a new piece of equipment is expected to generate a return
greater than what is expected for the project’s risk (its cost of capital).
But how can a firm create value simply by investing in a piece of equip-
ment? How can it maintain a competitive advantage? If investing in this
equipment  can  create  value,  wouldn’t  the  firm’s  competitors  also  want
this  equipment?  Of  course—if  they  could  use  it  to  create  value,  they
would surely be interested in it.
1 Lois  Therrien,  Patrick  Oster,  and  Chuck  Hawkins,  “How  Sweet  It  Isn’t  At  Nutra-
Sweet,” Business Week (December 14, 1992), p. 42.2 Monsanto sold its sweetener division in 2000.
29-Strategy_FinancialPlan  Page 936  Wednesday, April 30, 2003  12:19 PM

Strategy and Financial Planning 937
Now suppose that the firm’s competitors face no barriers to buying the
equipment and exploiting its benefits. What will happen? The firm and its
competitors  will  compete  for  the  equipment,  bidding  up  its  price.  When
does it all end? When the net present value of the equipment is zero.


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